Bailout won’t solve Portugal’s economic woes

After months of speculation, Portugal has finally asked the European Union (EU) for a bailout and now the small country must likely endure a series of painful austerity measures, following the examples set by Ireland and Greece.

We have encouraged the Portuguese authorities to ask for support and that was commanded by the situation after what has happened previously in Portugal, said Jean-Claude Trichet, president of the European Central Bank (ECB).

The EU is expected to begin negotiations with Portuguese officials on the size and terms of a bailout package (Lisbon currently has a caretaker government in place since Prime Minister Jose Socrates resigned last month after parliament refused to approve his austerity budget).

I always said asking for foreign aid would be the final way to go but we have reached the moment, Socrates has said.

The [European] Commission stands ready to send a mission to Lisbon along with European Central Bank staff as soon as we are asked to do so, said spokesman Amadeu Altafaj.

European Commission President Jose Manuel Barroso has expressed his confidence in Portugal's capacity to overcome the present difficulties, with the solidarity of its partners.

BBC's business editor Robert Peston estimated that Portugal might seek a loan of up to 80-billion euros ($115-billion), which would equate to about half of the country’s GDP in 2010.

Diego Iscaro, senior economist at IHS Global Insight , warns that the bailout will not solve Portugal’s economic woes.

“However, it could give Portugal time to put its public finances onto a sustainable path and introduce the structural reforms the economy so badly needs to be more competitive,” he said.

“The terms on which Portugal will receive the liquidity support will have to be negotiated, but they are likely to be similar to those offered to Ireland a few months ago.”

Portugal’s financial problems were largely caused by “muted growth prospects stemming from an extremely uncompetitive economy and a large fiscal deficit,”

Iscaro further points out that more austerity will have to be imposed to bring the fiscal deficit of 4.6 percent of GDP in 2011.

“However, the political hole left by the collapse of the [Socrates] government means that strong action in this respect is unlikely to be taken before the new administration is in place, which is unlikely to be before the end of June, “he said.

“We believe that a bailout could help Portugal go ahead with its fiscal reduction program and introduce the reforms the economy so badly needs in order to become more competitive without having to suffer the current suffocating pressure from bond markets. However, a bailout is not the solution to Portugal's problems. It will only be helpful as long as the public finances are put onto a sustainable path and structural reforms are implemented. This will be challenging.”